“Hedge funds posted their best first quarter since 2006 but lagged equity markets as managers were conservatively positioned,” commented Charles Gradante, Managing Principal of Hennessee Group. “However, with 77% of stocks currently trading above their 200 day moving average, many managers believe the market may be due for a correction.”

“Hedge funds have performed well given their low net exposures. Stock selection on the long side generally outperformed the market,” said Lee Hennessee, Managing Principal of Hennessee Group. “However, managers did express some frustration on the short side of the portfolio. Many high beta short positions rallied more than the overall market in the first quarter, detracting from performance.”

Equity long/short posted gains in March, as the Hennessee Long/Short Equity Index advanced +0.95% (+4.87% YTD). The equity market rally continued as the euro zone stepped back from the brink of collapse, the U.S. economy continues to improve, and central banks continue to support economic growth. In March, the S&P 500 broke 1,400 and the Dow Jones Industrial Average surpassed 13,000. Financials (+7.31%), technology (+5.03%), consumer discretionary (+4.44%) and healthcare (+4.27%) were the top performing sectors, while energy (-3.4%) was the only sector to experience a loss. Managers are optimistic as the economy continues to improve, but cautious as stocks have had a strong run and appear overbought. Some managers are concerned about profit margins. Declining profit margins could pose a problem for the stock market in a slow-growth environment. Managers are encouraged that correlations have declined and prices are responding to fundamentals. As a result, hedge funds have increased gross exposure, while net exposure has remained relatively stable.

“While markets have been strong and sentiment is bullish, managers have several longer term concerns. Europe is likely in a recession. The finances of Portugal, Spain and Italy are still in terrible shape,” commented Charles Gradante. “China and other emerging markets are seeing economic growth slowing. The U.S. faces political gridlock and uncertainty ahead of the November election. Lastly, rising gas prices threaten consumer spending. The challenge for hedge funds is participating in the upside of the rally without getting caught with too much exposure if the markets have a sharp reversal.”

The Hennessee Arbitrage/Event Driven Index advanced +0.78% (+4.55% YTD) in March. Investor risk tolerance continued to improve during the month as both equities rallied and spreads tightened. Treasuries declined as U.S. fixed income yields rose sharply on improving U.S. economic data and increasing investor risk tolerance. The Barclays High Yield index fell -0.1% (+5.33% YTD) as yields edged fractionally higher over the final two weeks. The Hennessee Distressed Index increased +0.96% in March (+5.60% YTD). Distressed posted gains as corporate credit spreads tightened, liquidity improved and financial equities rallied strongly. The Hennessee Merger Arbitrage Index advanced +0.42% in March (+3.02% YTD). Managers experienced gains as deal spreads tightened, specifically El Paso & Kinder Morgan and Glencore & Viterra deals. Global deal volume in the first quarter was the slowest start to a year since 2003, according to Dealogic. While managers remain optimistic due to huge cash reserves, low interest rates, and the need for growth, CEO lack confidence needed to do deals. The Hennessee Convertible Arbitrage Index returned +1.12% (+4.95% YTD). Convertible valuations were steady in March, in line with other risk assets. New issuance picked up in March as issuers took advantage of higher equity prices, stable credit markets, and low interest rates.

“Gold has experienced a pull back as fears about the European Sovereign debt crisis have receded and the odds of QE3 have diminished due to better economic data,” commented Charles Gradante. “However, many hedge fund managers are still long gold due to low interest rates and the debasement of reserve currencies.”

The Hennessee Global/Macro Index declined-0.02% (+4.57% YTD) in March. International equities fell, as the MSCI EAFE Index declined -0.91% (+9.97% YTD). International hedge fund managers were positive, as the Hennessee International Index advanced +0.55% (+5.47% YTD) in March due to an overweight position in the U.S. Emerging market declined in March with the MSCI Emerging Markets Index falling -3.52% (+13.65%). Hedge fund managers also declined, as the Hennessee Emerging Market Index declined -1.28% (+4.86% YTD). Macro managers experienced losses in March, as the Hennessee Macro Index fell -0.28% (+1.42% YTD). Managers had gains in currency and fixed income exposures, but suffered losses in commodity exposure. The U.S. dollar gained +0.3% against a basket of six currencies on higher U.S. yields. Managers continue to short the euro and the yen. Treasuries declined -1.0%, and managers partially covered 30-year Treasuries as yields increased from 3.08% to 3.35%. Commodities detracted from performance as the S&P GSCI fell -2.1% in March, the most since September. Gold also declined as the safe haven has fallen out of favor, falling -6.5% in March.

(press release)

Hennessee Group LLC is a Registered Investment Adviser that consults direct investors in hedge funds on asset allocation, manager selection, and ongoing monitoring of hedge fund managers. Hennessee Group LLC is not a tracker of hedge funds. The Hennessee Hedge Fund Indices® are for the sole purpose of benchmarking individual hedge fund manager performance.